(Peter Jacobsen, Foundation for Economic Education) Inflation has ruined one of my go-to examples for my macroeconomics students.
Whenever I discuss inflation with my students, I test their understanding of economics by highlighting the puzzle of the Dollar Tree, an American retail chain that sells goods at discount prices. Between the year the Dollar Tree was founded (1985) and today, the price of goods and services have risen 2.63% on average every year.
However, in spite of unpredictable swings in the economy and prices, one store has remained consistent throughout it all. Dollar Tree has long been known for being the last true “dollar store” which spans the whole US. For the last 35 years, when you walked into the Dollar Tree, you knew you wouldn’t spend more than one dollar per product.
All of that is changing, however. After 35 years, the Dollar Tree has announced they’ll begin to carry products with a price over one dollar. This invites two important questions: how was the store able to keep prices low for so long, and what is changing now?
Dollar Tree and the Art of Shrinkflation
To figure out why the Dollar Tree has decided to raise prices now, it’s important to consider why and how they’ve gone without changing prices for so long. As any bargain shopper knows, the Dollar Tree isn’t really the cheapest option out there. Buying large quantities in bulk is going to get you the best per unit money price every time. So if the Dollar Tree isn’t offering the cheapest per unit price, what’s the draw?
In a word: consistency.
Consumers like consistent prices and product availability. There’s nothing more annoying than going to a store and seeing an empty shelf or a price tag double what you expected. People know what to expect at the Dollar Tree. Need a box of candy for a movie? That’ll be one dollar please. Looking for a travel size shampoo? You know where to find it. Want a cheap toy for your kids? No sticker shock at the Dollar Tree.
This is why Dollar Tree is so resistant to price changes. In a world of credit cards, is $1.50 that much harder to swing than $1? Not for most. But that isn’t the point. People appreciate the one-dollar ceiling at the Dollar Tree. It makes it easy to plan.
But how does the Dollar Tree do it? When there is inflation, the value of a dollar falls. How can the Dollar Tree offer the same products year after year in exchange for a less valuable dollar?
Let me answer that question with another question. Why don’t you buy all your phone chargers at the Dollar Tree?
The Dollar Tree does carry chargers for phones, and they’re certainly cheaper than the prices on Amazon or at Walmart. So why doesn’t everyone get their phone charger from the Dollar Tree?
Most of you probably have an answer. Dollar Tree phone chargers are awful.
If you buy a phone charge from the Dollar Tree, it’s probably because you had an emergency. You know that it will probably only work for a day before it breaks. And here is our answer. The Dollar Tree doesn’t offer the same products every year for a less valuable dollar. They offer worse products for the less valuable dollar.
By spending additional resources, companies that make phone chargers can make them more resistant to wear and tear. If you have an iPhone, you may have at some point purchased a charger with a metal cover rather than the cheap plastic that breaks. These chargers are better, but they’re more expensive to produce. The Dollar Tree can use this logic in reverse. By making their phone chargers lower quality every year, they’re able to offset the fact that the one dollar used to purchase the charger is less valuable.
Another way the Dollar Tree can keep their prices low is by shrinking the size of a product. Is the dollar 5 percent less valuable this year compared to last year? Easy fix—make your shampoo bottles hold 5 percent less shampoo. Economists call the practice of reducing the quantity or quality of a good while keeping its price the same shrinkflation.
Shrinkflation is a form of inflation because you’d have to spend more money to get the same quantity or quality as you did in a previous year. The prices have remained the same, but the products are worse.
The Limits of Shrinking
It’s no secret that the US is experiencing higher than desired inflation over the last year. Recent inflation numbers show inflation well above the 2 percent target set by the Fed. Some measures have inflation at its highest rate in three decades.Just recently, Atlanta Federal Reserve President Raphael Bostic admitted inflation “will not be brief.” This flies in the face of Federal Reserve Chairman Jerome Powell’s claims over the last few months that inflation would be “transitory.”
So, inflation is higher, but then why would Dollar Tree raise its prices? Why not just use shrinkflation techniques to combat inflation? The answer is straightforward—there is a technological limit on how low quality you can make your products.
Consider, again, the Dollar Tree phone charger. People don’t mind the bad quality, because they expect it. If it breaks after 5 charges, there’s no surprise. Here’s the problem though: there is a minimum amount of inputs you need to make a charger work. If the Dollar Tree tries to cut the use of raw materials like metal in a charger, there’s only so much they can cut before the charger doesn’t work at all. If a charger doesn’t work for at least one charge, selling it is simply fraud. There are technological limits of shrinkflation.
The unprecedented move by Dollar Tree is unsurprising, then, given higher rates of inflation. Therampant money printing since January 2020 has caused the value of the dollar to fall, and Dollar Tree has decided that the cost of trying to force the quality of some products down even further is greater than the cost of alienating customers by raising some prices above a dollar.
So, although $1.50 phone chargers may not be the end of the world, I believe this change is a signal. It’s a signal that high price levels are expected to persist, and even the store with the stickiest prices must now let them rise. Inflation fought a 35 year war with the Dollar Tree, and, in the wake of unprecedented money-printing, inflation won.
Peter Jacobsen is an Assistant Professor of Economics at Ottawa University and the Gwartney Professor of Economic Education and Research at the Gwartney Institute.